Can investors have a conscience?

19 March 2008
It has never been easier to make socially responsible choices. From free-range eggs in supermarkets, to Fair Trade clothing, environmental washing powders and even green mortgages, we are able to do our bit to make the world a better place without making drastic lifestyle changes.

One area that has enjoyed the increasing popularity of environmental and ethical causes is the investment market. Ethical funds have been around since the early 1980s, but in the last few years more funds have sprung up and investors are increasingly looking at this area as part of their portfolio strategy.

In 2007, 1.3% of all retail investor sales were in socially responsible investment (SRI) funds, up from 0.7% in 2006 and equal to £473.8 million, according to the Investment Management Association (IMA). There certainly seems to be demand for SRI opportunities but a lack of confidence in the ethical credentials of firms seems to be holding some investors back. Research by Mintel reveals 66% of people believe green and ethical claims are just a PR stunt.

And a recent report into socially responsible investment (SRI) carried out by wealth managers Holden & Partners found that most so-called ethical funds’ top 10 holdings are fairly mainstream, and include companies such as Vodafone or Royal Bank of Scotland. Some even features names like BP, Shell and Total. However, very few included companies that directly tackle climate change in their top 10 holdings.

It also found that even pure environmental funds, despite purporting to focus on green companies such as wind energy and solar power firms, had some surprising holdings such as Porsche and Nestlé.

SRI funds on the market range from pure environmental, such as climate change, to ‘ethical’ - covering a range of different issues to sustainable funds. For investors, it can be hard to know exactly what issues different funds will address. But with pure ethical funds increasingly disregarded as limited, more people are turning to broad socially responsible or sustainable funds in order to make healthy returns without compromising their conscience.

What is socially responsible investing?

According to the IMA, socially responsible investments or ethical funds “aim to avoid companies involved in activities believed to be harmful, such as tobacco production or child labour” or “actively invest in companies which promote ethical policies such as recycling”.

The definition of what is ethical is what makes this area of investment so controversial.

As Alan Stokes, head of multi-management funds at Laurence House Fund Managers, says, this is a grey area as a company that is seen by one person to be ethical may be completely unethical to another person.

For example, Stokes says: “During the Falklands war the British army used a weapon to shoot Argentinean planes out of the sky. The company that made this weapon was also a major producer of premature baby units. So on one hand this company was involved in the production of weapons but on the other it was pioneering lifesaving technology. Whether it would qualify as ethical or not is a hard call.”

There are a variety of ways SRI funds screen companies for their portfolios. Ethical funds tend to use either negative or positive screening. The former involves screening out companies that are involved in certain areas – such as tobacco or arms – or have a bad record for polluting or violating human rights. Positive screening tends to focus only on companies that provide a solution to social or environmental problems, such as wind farms.

SRI funds may use a scoring system to screen funds, choose the “best in class” companies in any sector (potentially including unethical sectors such as pornography) or choose a range of companies based on a specific theme.

Engagement is another technique used by SRI funds. This is where they pick companies that may not produce an entirely ethical product but are open to conduct their business in a socially responsible and sustainable way. The fund then uses its influence to guide the company down the ethical route.

Julie Quinn, a fund manager on Norwich Union's sustainable investment team, says engagement offers benefits to the companies themselves as well as investors. She said: “We use engagement to not only improve our understanding of companies but also to help convince them that it is in the interest of their stakeholders (and therefore them) to improve their sustainability.”

Funds that focus on sustainability are, according to Quinn, a middle ground for investors keen to make a profit while still helping the world be a better place. The Norwich Union funds include several mainstream names, such as Tesco and HSBC, and Quinn says the aim is to capitalise on the increasing awareness of sustainability among consumers as well as new requirements on firms.

She said: “Ethical funds that focus on specific issue have their place but our central premise is sustainability as this has an impact on everyone regardless of their specific morals or ability to invest.”


Holden & Partners, which engages in socially responsible, ethical and environmental investing, says socially responsible, sustainable and ethical funds perform just as well as mainstream funds, and in some cases slightly better.

It says: “The environmental economy is enjoying strong growth and there are many funds out there making some very attractive returns for investors. But it is a complex area and we would recommend that anyone interested in making an investment seek financial advice.”

Another report by independent investment consultants Jewson Associates found that, over the long-term, investors taking an ethical approach did not have to sacrifice profit, although there was an increase in risk.

However, Matt Pitcher, wealth manager at Towry Law, says investors should never put their money into an SRI fund under the assumption that it will do better than a mainstream alternative.

He said: “This is the wrong approach to investment. You should only consider SRI if you are driven by genuine ethical concerns. You should also take into consideration that, as a result of those concerns, your investment might not make as much money as it could elsewhere – you may even make a loss.”

Ethical investors should also be clear about the criteria of their chosen fund and ensure that it fully fits within their own aspirations and morals.

Stokes says: “Choice is important but investors must understand the implications of their choice. You may get a better performance elsewhere.”

But according to Quinn, SRI funds are not about sacrificing profit for the “feel good factor” – in fact, she says investors should expect such funds to outperform.

“Sustainability is the future of investment. We use all the same valuation techniques that other funds use but we also have our own research that looks at the sustainability of each business model, consumer trends and regulatory changes,” says Quinn.

“There is an assumption that SRI funds underperform but I do not accept that - we should outperform our peers because of what we do - not despite it.”

She added: “It’s a fact of life that financial advisers only recommend SRI funds to people that show interest in ethical ideas but hopefully that will change over time as people see that they can make money and still have a conscience.”

Other types of SRI

Stockmarket jitters and an uncertain economic outlook may put some investors off equity funds. But there are alternatives such as social or peer-to-peer lending.

A recent report by Gartner Research predicts peer-to-peer lending will represent 10% of the personal loan market by 2010. According to social lending website Zopa this type of investment allow ‘lenders’ to earn average returns of 7.5% per annum (before tax but after bad debt and fee) by offering loans to ‘borrowers’. It says the risk is low, with an average default rate of under 0.1%.

Martin Campbell, spokesman for Zopa, says the majority of investors using the site are driven by the returns and low level of risk, but are also attracted by the ethics of social lending.

He said: “As well as helping other people by giving them loans, peer-to-peer lending has a social side and is a way to avoid giving money to big business. People wouldn’t do it if it wasn’t financial beneficial but it also offers a middle-ground where they can feel good about where their money is going.”

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